Stabilizing the Economy: The Role of the Fed

Flashcards covering definitions and key concepts from the lecture notes on the role of the Federal Reserve (The Fed) in stabilizing the economy, including monetary policy, interest rates, money supply, and tools used by the Fed.

Monetary Policy

A major stabilization tool, quickly decided and implemented, and more flexible and responsive than fiscal policy.

Demand for Money

The amount of wealth held in the form of money. It increases with income but decreases with the nominal interest rate.

Greenspan briefcase indicator

Analysts attempt to forecast Fed decisions about monetary policy

The Fed and Interest Rates

The money supply and demand determine the interest rate. The Fed manipulates supply to achieve its desired interest rate.

Money Demand Curve

Shows the relationship between the aggregate quantity of money demanded and the nominal interest rate (negative slope).

Open-Market Operations

The Fed primarily controls the supply of money with open-market operations. Purchases increase the money supply, sales decrease it.

Nominal Interest Rate

The higher the nominal interest rate, the smaller the quantity of money demanded

Equilibrium in the Money Market

Bond prices are inversely related to the interest rate

Federal Funds Rate

The rate commercial banks charge each other on short-term (usually overnight) loans; targeted by the Fed.

Real Interest Rate

Investment and saving decisions are based on the real interest rate.

Discount Window Lending

A lending facility offered by the Fed to banks; it increases reserves and ultimately the money supply.

Reserve Requirement

The minimum value of the ratio of bank deposits that must be held in reserves

Excess Reserves

Bank reserves in excess of the reserve requirements set by the central bank.

Zero Lower Bound

A level, close to zero, below which the Fed cannot further reduce short-term interest rates.

Quantitative Easing (QE)

The Fed buys financial assets, lowering the yield or return of those assets while increasing the money supply.

Forward Guidance

The Fed gives indications of its future policies so that markets will react.

Monetary Policy

decrease interest rates increase consumption and planned investment increase planned aggregate expenditure increase equilibrium output

Policy Reaction Function

Describes how the action a policymaker takes depends on the state of the economy

Taylor Rule

r = 0.01 + 0.5 + 0.5π